How much tax should I charge on this invoice?
Unfortunately, navigating the sales and use tax landscape sucks. There are over 13,000 taxing jurisdictions in the US and several services and software providers who will take your money to figure this out.
You definitely want to figure out sales taxes. Violating tax laws can eat your margins, shut you down, or in egregious cases, result in jail time. Perhaps most salient for founders, messing sales tax up can hurt your credibility with customers.
Assuming you are a well-intentioned, but just super busy founder, this post covers a few rules of thumb to help you decided when you need to solve this problem.
Disclosure: Talk to a tax accountant and/or tax attorney. This is general guidance and is not tax or legal advice. This guidance only covers SaaS business. If you sell physical goods, this isn't for you. For specific state guidance, contact that state.
The Basics of Sales Tax for SaaS Companies
- Sales tax is based on where the buyer is, not necessarily where your business is located.
- SaaS is taxable in some states, but not others.
- Your requirement to obtain a permit to collect sales tax on sales in a state is based on your nexus to that state.
- You have to obtain a permit in order to collect sales taxes. You are acting as a tax collector on behalf of the state.
- If you do not have nexus, and therefore are not required to collect sales tax, your customer may still be subject to remitting a use tax directly to the state.
So the logic goes...
Seller has nexus > sale is taxable > seller collects and remits sales taxes to state customer purchases product in
Seller does not have nexus > sale is taxable > buyer remits use taxes to state customer uses product in
TLDR; you only have to worry about the top left quadrant. First determine where you have nexus, then determine if SaaS is taxable.
Where do I need to collect sales taxes?
You need to register for a sales tax permit and collect taxes where ever you have nexus. Nexus is required by the Commerce Clause of the US Constitution: in order for a jurisdiction to tax you (therefore impairing interstate commerce), you must have a connection to it. This connection can be physical or economic.
You have physical nexus where you are physically located.
For SaaS companies, this includes wherever you have employees or an office. On the off chance you have physical storage or manufacturing, that counts, too. You need to register for a permit or license with these taxing authorities.
You may have economic nexus where you sold more than $100,000 or 200 transactions in the last year.
The South Dakota v. Wayfair case expanded the physical presence requirement and opened this can of worms. It's called **economic nexus**. Each state has a different definition ("and" vs "or;" higher limits, all sales vs taxable sales, revenue vs income, etc.), but the Wayfair case set these minimums. Basically, you don't need to evaluate economic nexus in a state unless you are approaching the $100,000 in sales or 200 in transactions to customers in that state.
You may have nexus where you performed other seemingly random business activities.
These states want your money, y'all. Attending a trade show might establish nexus (physical nexus). Signing an agreement with a referral partner or even an influencer that directs clicks to your website might establish nexus (click-through nexus). Some states also count having affiliates like outsourced design, engineering, or sales teams (affiliate nexus). Storing inventory with a third-party provider might establish nexus (physical nexus).
If you only have economic nexus only, you are a "remote seller" in the states where you sold stuff.
Avalara has an excellent interactive breakdown of nexus definitions by state.
Where is SaaS taxable?
SaaS is taxable based on the situs or location where the buyer benefitted from the software.
Use the buyer's address
For SaaS, it is common to use the billing address on the contract to determine this location. Shipping or main office address where the software will be used is better if you have it. The address must include the street address, not just city, state, and zip, because taxing jurisdictions are that nuanced.
Determine nature of your product
SaaS is still "new" in the world of governments, so it's quite the patchwork of SaaS taxability and justifications for doing so. Some states consider it to be just another service and tax it as such, while others consider it a tangible good. Some tax it if any physical good is delivered or if there is a downloadable component. Some tax SaaS for personal use, but not business use. And others do the opposite.
Review State (and in some cases City) laws
Five states have no sales tax (Alaska, Delaware, Montana, New Hampshire, Oregon). 19 do not tax SaaS if there is no download required or tangible product delivered. Six tax SaaS if a download is required or tangible property delivered. Leaving 21 states that tax pure SaaS. In Home Rules States including Alabama, Alaska, Arizona, Colorado, Illinois, Louisiana, and West Virginia, local jurisdictions can collect sales tax rules & rates.
Stripe offers a good chart showing in which states SaaS is taxable. It does not include local jurisdictions, so if you meet nexus in Home Rule States, you'll need to look into taxability and rates in local jurisdictions.
What happens if I don't collect sales tax?
Your customer might be required to pay use taxes
If what you are selling is taxable where the buyer is, but you don't have nexus, the buyer may still be subject to remitting use tax. For example, if you sell SaaS software to a customer in Texas and you didn't collect taxes, the buyer would have to remit use tax if they exceed the $1,000 threshold for reporting and remitting use tax.
You might have to pay the taxes out of your sales anyways, potentially with penalties
If you trip nexus in a state and do not file for a permit and collect taxes, you will be on the hook for those taxes out of the revenue you collected, plus late fees of about 10-20% in most states and potentially interest. So if you sold $100k in a state where SaaS is taxable and you didn't collect taxes that say run 10% for easy math, you might owe $9k in back taxes + penalties.
The good news is that you have to be a fairly large business for sales tax to turn into a huge headache and you'll have someone handling it. Until then, be mindful of where you establish nexus, register for a sales tax permit where you have nexus, and collect sales tax only where you have nexus.
Sales Tax Operations for Founders
- Sales tax does not count toward revenue. Put it in a separate tax liability account until you remit it. Make sure you keep enough cash to pay your tax liability.
- If a customer is exempt from sales tax, you need to collect documentation of their exemption.
- Do not include specific tax amounts on order forms. It only confuses buyers during the sales process. Include a footnote like "This is not an invoice. Customer will be responsible for payment of necessary taxes on the Subscription Services."
- The Tax Foundation maintains current sales tax rates by state, with some info on local jurisdictions.
